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Thursday September 21st, 2023

Sri Lanka goes from boom-bust to bust-bust with soft-peg: Bellwether

ECONOMYNEXT – Sri Lanka is going from boom-bust to bust-bust in this credit cycle despite the injection of excess demand into the economy by the central bank, with currency depreciation and capital outflows taking their toll and a Weimar Republic style default looming due to the soft-peg.
Sri Lanka has had boom-bust cycles in the past primarily due to the Central Bank’s failure to allow rates to rise as credit demand picked up in the recovery period. The Federal Reserve, however, is raising rates as the economy is picking up.
But the Fed has a floating rate and does not intervene in forex markets and print large volumes of money (like quantity easing) even if it did cut rates because the US has a floating exchange rate with no convertibility undertakings, explicit or otherwise. As credit recovered, the Fed in fact has been reducing excess liquidity created during quantity easing after credit collapsed.
Sri Lanka’s budgets have been blamed for generating boom-bust cycles by the Central Bank. It has accepted no culpability. But Boom-bust is an inherent side effect of all credit cycles.

This belief that budgets are a source of excess demand is a dangerous misconception. A budget cannot infuse a lot of excess demand unless the credit system is contracting and the excess liquidity it uses comes from a private credit contraction.
A budget will simply transfer spending power from buyers of bonds to the Treasury. If at all, state spending, which may involve putting other people’s money in low return projects, will reduce long term growth.
The Central Bank has to avoid firing any recovery with new money to make the boom worse with pro-cyclical policy (through open market operations or purchases of Treasury bills at auctions) and allow market rates to take care of the problem and minimise its effects.
Having said that, there is evidence that some Central Banks have been able to reduce the boom quickly (Canada, Australia, New Zealand) as the Fed is trying to do now. The secret may be a good consumer (headline) inflation index that does not hide inflation.
Even in free banking days, there have been credit cycles around the world, though they were not as bad as the ones that came after the creation of the Federal Reserve.
However, there is no point in comparing the Fed to the Central Bank; they operate regimes which are polar opposites.
Sri Lanka is operating a soft-peg with explicit and implicit convertibility undertakings. In such a regime, any money created from domestic asset purchases, which has no foreign assets to back it, and make good the CU (convertibility undertaking) is printed money.
Last year, the Central Bank loosened policy and injected cash into money markets just as the economy was recovering.
"Sri Lanka is at the bottom, and was just starting to recover from 2016 bust when the depreciation hit again," this column said last year in Sri Lanka and Ecuador; a cautionary tale of the Rupee and Sucre.
"It is one thing to have a boom-bust. It is quite another to have a bust-bust."
"If the Vietnam Dong collapses in the next year, despite rocketing exports, their people would have got many benefits during the decade-long boom."
In 2018, as the rupee came under pressure from excess liquidity, and credibility in whatever convertibility undertakings was lost, the recovery stalled and growth slowed.
In the 2011/2012 balance of payments crisis, there was strong growth as money was injected through terminated term repo deals (a bit like Central Bank of Argentina creating a secondary market for its own sterilisation securities to generate the latest Peso collapse).
The Yellow GDP growth went up sharply with the printed money growth (net credit to govt).
Growth was strong for two reasons. One was that the currency peg was kept until 2012, preserving the real value of the current for people to invest or consume most of the printed money.
The other reason for stronger growth was that foreign investors in bonds such as Templeton did not sell.
Foreign bond holders held back because the rupee was allowed to appreciate during the ‘bust’ period (credit contraction) that followed the liquidity injections in the 2008/2009 crisis.
However, after the rupee fell to 131 to the US dollar in the 2011/2012 crisis and it was not allowed to appreciate, foreign investors had second thoughts. Plus the UNF administration also got into some public spat with Templeton, which may have sent bad signals.
In both the 2015/2016 crisis and 2018 runs on the rupee, foreign investors sold out strongly. Using the printed money from open market operations banks then bought the bonds sold by foreign investors instead of giving credit, reducing the resources available for domestic players.

Currency depreciation also destroys real purchasing power. For example, it costs more to build a house as building material prices go up due to depreciation. Meanwhile potential buyers of houses or any other good will also find less money available as fuel or other costs go up.
Growth is now slow, around 3 percent. Sri Lanka’s growth may look slow due to the changes made in the way it was calculated after 2015, when GDP was estimated to be bigger. But over time they should balance out (items like revenue to GDP will be lower).
If the Census Department consistently undercounted GDP, eventually total GDP will be low and GDP growth will show the ‘correct’ number because the same assumptions or errors will be made consistently.
However, bust-busts have many other implications. If not for the halting of mopping up auctions in February and rate cuts and cash injections in April, Sri Lanka would be on a strong recovery cycle, backed by the end of the drought.
However it was not to be, due to capital outflows and the currency collapse. But a more deadly result of a bust-bust cycle is that killing domestic demand with currency depreciation leads to business failures, resulting in bad loans.
That is also why this columnist advocated open market operations or unsterilised defence to generate a liquidity short, hiking rates, and quickly floating to re-establish confidence in the peg.
Prolonged liquidity shortages have severe consequences. This is another problem with soft-pegs. Hard pegs, which have credibility, rarely have such problems.
While Hong Kong’s peg was hit by speculators in the 1997 crisis, the confirmation of its credibility resulted in excess liquidity during the 2008 global crisis, as resident firms and banks brought funds back home.
Sri Lanka’s rupee peg is non-credible. A REER target is going out of its way to undermine its credibility. Therefore it is better to hike rates, allow the liquidity shortage to spread through the banking system and then float, and ‘get it over’ as the saying goes each time a monetary policy error is made.
Multiple Runs

In February 2018, there were strong signs that the second run on the central bank had ended and the rupee was stabilising.
However, emerging data showed that even in January, the Central Bank had bought dollars. It is a mistake to buy dollars too soon. The rupee should have been allowed to appreciate like in India.
The marginal cut in the money printing auction from 9.0 percent to 8.75 percent in recent days is also extremely premature. It is premature because 2019 has a lot of debt repayments. For the same reason, the rupee should be allowed to float cleanly and appreciate before the Central Bank purchases dollars.

In 2018, the Central Bank generated the second run after the rupee stabilised in August.
Weak private credit allows the credit system to stabilise faster than in earlier crises, when business confidence was stronger and the rupee had been stable for longer periods before that, preserving purchasing power.
What is happening now is that borrowers are getting more acclimatised to higher rates. To fix the next run, even higher rates may be required.
Data seems to show that liquidity shortages are developing again in February, which is not a good sign.
Debt Repayment

What is happening to Pakistan should be a warning. It is a wrong strategy to repay foreign loans purely with new borrowings with a depreciating currency.
Sri Lanka’s rating is at now at ‘B’, which is too close to ‘CCC’ for comfort. Going for large borrowings at one go will spook investors. It is better to go for usual volumes and go to markets a second time, even at a higher rate, after investors get comfortable.
Ever since the last regime ended privatisation, then re-nationalised agencies like SriLankan, expropriated others, bought back Litro Gas and generally had an unfriendly attitude towards free enterprises, and the backing of crony businesses with protectionism, this country had been going down the low growth-default path.
The infrastructure drive with Chinese loans would have made sense if more private investors were allowed to come in. Even on expressways built with people’s money, private buses were not allowed.
A Fool’s Paradise
The REER pegging depreciation will also contribute to debt default pressure. It is a completely wrong claim made by the Central Bank and other official commentators that depreciation brings more revenues to the state.
Depreciation expands the budget. It is simply not shown as an expense despite depreciation being a cash flow rupee item. Why it is not done is not clear.

During the British period, when Sri Lanka had currency board, depreciation was not a factor.

Even after the Central Bank was created and money was printed, the exchange rate was maintained with trade and exchange controls. It may have contributed to the way budget numbers are calculated. The IMF, which also tends to depreciate soft-pegs to re-establish credibility, would prefer not to take into account depreciation.
A similar strategy is followed with the so-called Primary Deficit. It is a target that keeps policy rate hikes off the table. It may make sense since policy rate hikes are needed to fix problems. But like depreciation, the interest cost is there.
There is no path to prosperity through depreciation.
Monetary Stability

The first priority in debt repayment is to re-establish confidence in the peg.
Borrowing more dollars to repay debt is not the only answer. It is also a mistaken idea to think that there is some shortage of ‘foreign currency’.
There is no shortage of foreign currency to repay debt if the Central Bank maintains monetary stability and mops up a part of the inflows and avoid debacles like in April and August.

Such a strategy requires a slightly higher interest rate than the market clearing rate (the currency board rate say) that allows the domestic banking sector to lend all the money it raises as deposits or loan repayments.

A sale of sterilisation securities into the banking sector at the required domestic interest rate will generate ‘forex savings’ by keeping imports and the so-called current account below full potential.

It is not possible to shrink the entire external current account to repay all the foreign debt in one go and convert them to rupee debt. It may generate negative growth. But it can be done to some extent. Sri Lanka has been doing it for decades.
After all, in the old days the IMF loan was given for just that reason. IMF loans would re-build reserves and give immediate confidence, allowing reserves to re-built slowly without shrinking the current account too much.

But the IMF programs have, in recent years, institutionalised the contradictory policy of soft-pegs with an inflation target coupled with a forex target.

This column said at one time before the 2015 liquidity injections that Sri Lanka cannot afford to take monetary risks with commercial foreign debt. It is even more so now. Trigger-happy domestic operations are even more dangerous with a B credit rating.
It is perfectly acceptable to have another quarter of low growth if the result is to push the peg to the strong side of the convertibility undertaking. Borrowing abroad will not help, if the Central Bank’s Domestic Operations Department keeps injecting new money for whatever reason, belief, ideology, or theory.
There have been some claims made that budget deficit injects excess demand. The Treasury cannot print money. It can only transfer purchasing power from purchases of bond holders to itself. Excess demand comes if the Central Bank accommodates the deficit with printed money.
No Fiscal Dominance
2018 proved beyond doubt that political pressure was not the reason for monetary instability. State Minister for Finance Eran Wickremaratne publicly said the Central Bank was independent.
Finance Minister Mangala Samaraweera slapped import controls despite getting egg on his face and undermining the entire free trade strategy of the administration just to contain the negative effects of monetary instability.
And Sri Lanka had the extraordinary spectacle of Harsha de Silva, the State Minister of the ministry to which the Central Bank is assigned, pleading to allow rates to go up to the 8.5 percent policy ceiling.
Subsequently policy rates were raised to 9.0 percent.
It is not clear whether any politician of a developing country had ever urged a Central Bank to tighten instead of loosening.
Having said that, 2019 is an election year. So the budget will not be helpful. It is imperative that monetary stability is restored soon as possible and rates match the deficit.
More Chinese loans are not the answer to foreign debt repayment. The Dawes plan did not help the Weimar Republic.
Neither will new Chinese loans help Sri Lanka or Pakistan. China itself will learn the mistakes of those who had to engage in gunboat diplomacy. It seems that the People’s Bank of China and China itself is having higher interest rates after the strong peg was broken.
Let’s face facts. Keynes was wrong.  Bertil Ohlin was right. Later on, Robert Mundell was right. Marcus Fleming was right.

There is no transfer problem. Economic Consequences of Peace may have been a runaway success with English readers, buts its core argument was flawed. Similar arguments are repeated in Sri Lanka. Foreign debt repayment will slow domestic economic activity, but export surpluses are not a requirement.

Bretton Woods collapsed with the Fed’s own peg collapsing. So did the sterling. Little wonder that the rupee collapses.
But a mountain of debt denominated in a stronger currency was not a problem for the US. But it was a problem for the Weimar Republic. And it is a problem for Sri Lanka and also fore regional soft-pegs like Pakistan which is having problems now.

This column is based on ‘The Price Signal by Bellwether‘ published in the March 2019 issue of the Echelon Magazine. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here. To reach the columnist write to:



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Sri Lanka’s 2022 EPF returns falls to lowest, single digit in near two decades – CB data

ECONOMYNEXT – The 2022 annual average return on Sri Lanka’s largest contributory pension scheme, the Employees’ Provident Fund (EPF), has fallen to its lowest in nearly two decades, Central Bank data showed.

The annual average return in the last year fell to 9.52 percent from the previous year’s 11.40 percent, a central bank response to a Right to Information (RTI) request showed.

Returns on EPF has raised concerns among contributors after the government decided to include EPF investments in the government treasury bonds under the domestic debt optimization (DDO) process.

Last year’s lower return has been recorded despite market interest rates being more than 30 percent towards the end of the year. In contrast, the fund has given a double digit return in 2020 when the market interest rates hovered in single digits.

Analysts have predicted the returns to be further low with the central bank opting for the government’s DDO option.

A central bank analysis on DDO showed the return on EPF could fall to as low as 6.79 percent if the DDO option was not chosen within the next 12 years as against 8.02 percent if opted for DDO.

Trade unions and some politically motivated fractions opposed the government move to include the EPF investments under the DDO. However, parliament approved the move early this month.

According to the data made available from 2005, the central bank, which is the custodian of the EPF, has given the highest return of 16.03 percent in 2009.

The island nation’s largest pension fund has almost 21-million member accounts including 18.3 million non-contributing accounts due to some members having multiple number of accounts.

The 3.38 trillion-rupee ($10.6 billion) worth fund as of end 2022 is managed by the central bank, including its investment decisions.

As of end 2022, the central bank has invested 3.23 trillion rupees or 95.7 percent of the total EPF in government securities, while 84.1 billion rupees has been invested in listed companies in the Colombo Stock Exchange, the central bank said quoting the EPF audited financial statement. (Colombo/September 21/2023)

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Malaysia to support Sri Lanka’s bid to join RCEP

ECONOMYNEXT – Malaysia has agreed to support Sri Lanka’s application to become a member of the Regional Comprehensive Economic Partnership (RCEP), a major regional trade agreement.

The RCEP is a free trade agreement among the Asia-Pacific nations of Australia, Brunei, Cambodia, China, Indonesia, Japan, South Korea, Laos, Malaysia, Myanmar, New Zealand, the Philippines, Singapore, Thailand, and Vietnam.

President Ranil Wickremesinghe met the Malaysian Prime Minister Anwar Ibrahim during bilateral discussions on the sidelines of the United Nations General Assembly in New York yesterday (20).

During the meeting, the Malaysian Prime Minister expressed a strong desire to bolster economic ties between the two nations, according to a president’s media division statement.

He emphasized Malaysia’s eagerness to facilitate increased investments from Malaysian companies in Sri Lanka.

Ibrahim also expressed positivity towards Sri Lanka’s request to commence negotiations for a free trade agreement (FTA) between the two countries, which could potentially open up new avenues for trade and economic cooperation.

Wickremesinghe is in a drive to bolster international ties and integrate the country with the global economy.

So far this week he met with the leaders of Bangladesh, Nepal, Malaysia, Iran, South Korea, as well as representatives from global bodies such as the World Bank, International Monetary Fund, USAID, Meta, the Commonwealth, and attended other forums.

Sri Lanka aims to expand its economic reach first within South Asia and then extend further.
Data shows that Sri Lanka has been able to boost exports with FTAs.

Over the past two decades Sri Lanka’s exports have not grown as much as competitors.

Economists involved in trade have pointed out that Sri Lanka should make joining the RCEP a priority instead of trying to negotiate multiple smaller deals for which it does not have the bandwidth in government, or the technical resources to do multiple trade agreements. (Colombo/Sep21/2023)

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Is Tibet Prepared for a Post-Dalai Lama Era?

ECONOMYNEXT – Tibetans have shaped and sustained their lives for more than 60 years under the leadership of the 14th Dalai Lama. The spiritual leader turned 88 in July, and as his longevity is discussed amongst his followers, there is also concern about Tibet’s future without his physical presence.

In 2011, the Dalai Lama divested himself of all political authority, yet, as the architect of democratic governance, he continues to remain a larger-than-life figure for Tibetans.

Along with that come other challenges; safeguarding the democratic system he initiated, engaging younger generations in the cause for Tibet’s freedom, protecting the country’s environment, the influence of external forces and the possible geopolitical fallout of India’s continued support of the Tibetan cause.
Ever since the Lhasa uprising of 1959, and the setting up of a government in exile in Dharamsala, India, the first Tibetan Constitution introduced by the Dalai Lama in 1963 has undergone many changes.

In 1991 the Supreme Justice Commission was added to the other two pillars of democracy, the Legislature and the Executive. Along with that, an Independent Audit Commission, an Independent Public Service Commission and an Independent Election Commission were set up, and women were assigned two seats in the Legislature. The current operational body of the Tibetan government in exile is known as the Central Tibetan Administration (CTA).

The debate on Tibet’s sovereignty, which fell under the control of the Chinese in 1951, is ongoing, with the Chinese government terming it the “Peaceful Liberation of Tibet’ and the CTA and Tibetan diaspora referring to it as the “Chinese invasion of Tibet.”

Despite the reforms and the Dalai Lama divesting himself of all political power the spiritual leader exerts considerable influence and therefore there is still, a heavy dependence on him, notes MP Youdon Aukatsang. Speaking at a webinar titled “Tibetan Democracy in Exile’ organised by the Friedrich Naumann Foundation for Freedom, South Asia, on September 15, Ms Aukatsang pointed to a recent constitutional crisis which was finally resolved following the Dalai Lama’s intervention. “Tibetans must take full responsibility for political matters as envisaged by His Holiness the Dalai Lama,” she said.

There is also the challenge of dealing with the internal dissent amongst Tibetans, which she claimed is spearheaded by China.

The webinar moderated by Ms Tenzin Peldon, the Director and Editor-in-Chief of Voice of Tibet, included Ven Geshe Lhakdor, Director, Tibetan Library and Archives and honorary Professor, University of British Columbia, Gondo Dhondup, President of the Tibetan Youth Congress and Sujeet Kumar, an Indian parliamentarian and the Convenor of the All Party Indian Parliamentary Forum for Tibet.

The current Sikyong, Tibet’s political leader Penpa Tsering and Dr Jurgen Murtens, a member of the German Bundestag also addressed the webinar.

The democratic model, Aukatsang states is successful, yet it is a work in progress. The current make up of the Tibetan Parliament in Exile (TPiE) has 45 members representing the three provinces of U-Tsang, Do-med and Do-tod, the four schools of Tibetan Buddhism as well as the traditional Bon faith, Europe, North America and Australasia. It is headed by the Speaker and the Deputy Speaker.

Aukatsang would like to see a modification in the composition with more representation from the diaspora, and less from the provinces to better reflect the changing demography. She also proposes an increase in the number of members of the Standing Committee from 11 to 15 and calls for the establishment of a dispute resolution mechanism rather than the direct impeachment process, which is the current practice.

Though the 1991 reforms made way for women’s representation in the TPiE, (currently 10 ministers and the Deputy Speaker are women), Aukatsang is hopeful there would be “more meaningful engagement of women in leadership roles,” for, as she points out, they are the custodians of Tibetan culture and language. Women have also distinguished themselves as founders of several non-governmental organisations and in the field of education.

Her sentiments were reflected by the Sikyong, Penpa Tsering when he said that unless the administration is ready to adapt to demographic and social realities, its relevancy will be challenged.

When the Buddha was on his deathbed, and his followers were fearful of being on their own, the Buddha had advised that the focus should be on his teachings and not his physical presence. Likewise, says Ven Geshe Lhakdor, Tibetans must continue to abide by the teachings of the Dalai Lama, and not worry about his absence. When Tibetans were prohibited from displaying photos of the Dalai Lama, they hung up empty picture frames, he said, aware that the Dalai Lama remains within them.

Ven Geshe Lhakdor also advocates a separation of Church and State, pointing out that clergy must involve themselves in the spiritual upliftment of society, rather than in politics. The idea of the religious ruling a country is outdated, he points out, adding that once clergy get into a “political mindset” they are unable to send out good signals to the people. He adds that their responsibility is to safeguard culture and harmony and be role models.

The principles of democracy are a reflection of Buddhist teaching the Venerable noted, pointing out its time to extricate oneself from a tribal mentality. The focus must be on a long-term, robust vision, rather than quick fixes. He also believes that Tibetans must safeguard themselves from internal fragmentation, even more than external threats.

One unique feature of the administration is that it is free of corruption, the Venerable notes, despite being surrounded by corrupt systems.

Even though Jawaharlal Nehru, the first Prime Minister of independent India, sought and had the cooperation of all Chief Ministers to offer refuge to Tibetans in 1959, MP Sujeet Kumar is of the opinion that the current Indian Parliament is rather diffident in openly rooting for Tibet against China.

While acknowledging that Indian parliamentarians have huge constituencies and are busy, he is hopeful his colleagues would take more interest in Tibet and her issues.

Tibetans alone have the right to decide on the Dalai Lama’s successor, says Kumar, and India must back that. India should also rally the support of other nations to help Tibet charter her own course in a post-Dalai Lama scenario.

Kumar would like to see more Tibetan youth become part of India’s trillion-dollar digital industry.
He is concerned, however, at the lack of enthusiasm amongst the youth to use social media to fight disinformation being circulated about Tibet.

Acknowledging that youth could be more engaged in social media to fight disinformation, Gondo Dhondup says all Tibetans are “born to be activists” and to the cause, even though it is difficult to envisage a freedom movement without the Dalai Lama.

Youth are the agents of change, and Tibet’s future citizens, therefore they must stay informed. The TYC organises leadership training, and Tibetans, even those scattered around the globe must take advantage of the programmes, Dhondup says.

While calling on India to introduce a national policy on Tibet, Dhondup cautions that India’s waterways that originate in Tibet are under threat. The rivers are either “diverted or polluted” affecting downstream villagers, and India must ensure her water security, Dhondup explains.

The recently concluded G20 summit was themed “One Earth, One Family, One Future”, and that gives India an opportunity to be more vocal about the environment, he says.

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